The IKEA Effect

The discussion in the news media about whether or not Bain Capital’s investments were beneficial to workers and consumers is confusing to me. Venture capitalists allocate financial resources to enterprises where they expect a return on their investment. Often these returns come from gains in efficiency and productivity. Some productivity and efficiency gains result from new technologies. Others are the result of management changes that allocate human resources, inventories and equipment in a more cost-effective way. Efficiency gains allow a firm to compete more effectively in a world market and may cause product prices in the industry to fall, which benefits consumers. Neither venture capitalists nor economists evaluate an investment by whether employment in the targeted firm/industry increased. Many economically beneficial investments will cause labor-saving efficiencies and could conceivably reduce employment in the targeted firm or industry.

One of the great productivity success stories in the past twenty years has occurred in retail furniture stores in the U.S. Output per worker hour in furniture stores has more than doubled in the past 24 years, while output per worker hour in grocery stores has barely changed. The figure below shows that these large gains in labor productivity coincided with the entry of IKEA stores into U.S. markets.

IKEA stores attract customers because of lower prices. One reason for the lower prices is that fewer workers are required to sell furniture and home furnishing products in an IKEA (and stores that followed its lead) compared to traditional furniture stores. The primary result of this change is that consumers pay less for furniture. It also means that total employment in furniture stores in the US is about the same today as it was twenty years ago.

The displacement of workers caused by increased efficiency is both a challenge and an opportunity in a free enterprise system. Human capital that was previously employed in furniture stores can now be allocated to more valuable tasks in new ventures. This is likely to occur only if entrepreneurs invest in start-ups and new technologies and dislocated workers acquire the skills necessary to take advantage of these new opportunities.